by Thomas E. Johnson

In 2003, there were a record 1,660,245 bankruptcy filings, of which 1,625,208 (over 97%) were classified as "non-business" bankruptcies.1 Fueled by soaring levels of outstanding consumer debt, consumer bankruptcy filings for 2003 easily eclipsed 2002's record.

The consumer credit counseling industry has grown substantially in the past decade, in response to this economic crisis. Where ten years ago there were approximately 200 consumer credit counseling agencies across the country, there are now over 1,000 such organizations, serving over 1.5 million consumers.2

You need not be a bankruptcy practitioner or insolvency expert to come into contact with a client besieged by creditors. The divorce client, small business owner, injured or laid off worker, or any of a host of other financially distressed individuals may seek your advice on how to deal with the money troubles that are the cause or effect of the legal problem for which they first sought your advice. The purpose of this article is to provide a general overview of the options available to such individuals, to assist you in advising them or making an appropriate referral.

The "Do Nothing" Approach

For a significant number of individuals, no offense may be the best defense to creditor collection activity. Absent a viable threat of wage garnishment or seizure of assets, an impoverished individual may have no need to seek extraordinary relief from his or her creditors. Before advising a person to take this approach, however, you need a basic working knowledge of the laws relating to collection remedies and exempt property.

The bulk of the Minnesota exemption statutes are found at Minn. Stat. §550.37. Note that exemption laws apply only to individuals, not to artificial entities, such as corporations.3

Some of the items of property listed in the statute seem quaint (e.g., "the family Bible"; "a seat or pew in any house or place of worship") and are no doubt reflective of the early pioneer origins of these laws. Nonetheless, a cursory review of the statute reveals that all of the necessities of life are exempt from garnishment, levy, and execution on a judgment, at least to the extent of the dollar limitations set forth. Clothing and wearing apparel, household goods and furnishings, tools of the trade, a motor vehicle (including one adapted for use by a person with a disability), "earnings not subject to garnishment," and public assistance benefits are all among the types of property specifically identified as exempt in Minn. Stat. §550.37.

When it comes to wage garnishment, Minn. Stat. §571.922 limits the amount subject to garnishment to the lesser of: 25 percent of the debtor's "disposable earnings," or the amount by which the "disposable earnings" exceed 40 times the minimum hourly wage prescribed by 29 U.S.C. §206(a)(1) (currently $5.15/hour for most types of employment) per week, for the number of work weeks included in the debtor's pay period.4 Note that the limitations on garnishment apply only to a traditional employer-employee relationship; funds payable to an independent contractor or self-employed individual are probably not subject to the §571.922 limitations.5 "Disposable earnings" is specifically defined to mean "that part of the earnings of an individual remaining after the deduction from those earnings of amounts required by law to be withheld."6 Presumably, this refers to state and federal withholding and payroll taxes.

If your client is in a low-paying job, or working less than a full 40-hour workweek, she may very well have no "disposable earnings" subject to garnishment. This is not an uncommon scenario for persons working in a service-related industry. The lack of disposable earnings, when coupled with the relatively generous Minnesota personal property exemptions, may render an individual "judgment-proof." In this situation, the best advice to the individual may be to buy a cheap telephone answering machine to screen out the inevitable barrage of dunning phone calls.

This is not to suggest that the judgment-proof individual should be counseled or encouraged to take advantage of this status to continue to incur debt beyond his means. Rather, it is to point out that for some persons, insolvency may in fact be as effective as judicially determined insolvency (i.e., bankruptcy), in resolving a debt crisis.

Chapter 7 or Chapter 13 Bankruptcy

Persons who are de facto insolvent may nonetheless seek a determination of de jure insolvency. Their penurious circumstances may only be temporary, and an impending change of employment may make them vulnerable to wage garnishment in the near future. Judgments, while not enforceable against an exempt homestead, nevertheless cloud the judgment debtor's title to the property and title examiners will generally require the judgments to be satisfied or released upon the sale or refinancing of the property. Moreover, the majority of financially distressed individuals seen by the typical private practitioner will not fit the "do nothing" profile. For the oppressed consumer debtor, bankruptcy may be the appropriate solution.

The vast majority of individuals seeking relief under the Bankruptcy Code7 will file under either Chapter 7 or Chapter 13. While Chapter 7 enables a debtor to obtain a relatively quick discharge of indebtedness, Chapter 13 involves the creation of a "plan" to repay creditors, in whole or in part, over a period of time that generally ranges from 36 to 60 months. The choice of chapters depends on the individual's circumstances.

Under either Chapter 7 or 13, the individual must file a petition for relief, identifying the chapter under which relief is being sought, together with a series of schedules and statements. Within these documents, the individual must disclose all assets and property, all liabilities (even contingent and disputed ones), income and expense information, and other information related to the individual's current and past financial affairs.

The person filing for bankruptcy is allowed to claim certain assets and property as "exempt," which effectively removes the assets from the person's bankruptcy estate. Minnesota is one of a minority of states that allow debtors to claim exempt property under either the exemption statutes contained within the Bankruptcy Code or the exemptions provided by state and other federal non-bankruptcy law.8

In a Chapter 7 case, a trustee is appointed to take possession of, and liquidate, any nonexempt assets. In the vast majority of Chapter 7 cases, there are no nonexempt assets available for liquidation, so creditors receive nothing from the bankruptcy estate. However, certain debts may also be nondischargeable in a Chapter 7 case - either automatically (in the case of alimony and child support, for example), or after a timely-filed9 nondischargeability proceeding is commenced and determined in favor of the creditor. In such a case, although the creditor receives no payment from the bankruptcy estate, the debt is not discharged and the creditor is once again free to pursue the debtor. The listing of debts that are not - or may not be - discharged in a Chapter 7 case are found in §523(a) of the Bankruptcy Code. Caution should be exercised in reviewing this section, as the terminology utilized therein is very specific and often has been highly refined through judicial opinions.

In contrast to Chapter 7, Chapter 13 requires the consumer debtor to file a "plan" along with the other bankruptcy schedules and statements, in which the debtor outlines how he proposes to repay creditors. Like most states, the Minnesota bankruptcy courts have proposed a local form plan, and the plan submitted by the debtor must conform to the local form.10 In most cases, the debtor proposes a monthly payment to the Chapter 13 Trustee, based on the debtor's available disposable income as shown on his bankruptcy schedules. The Chapter 13 plan describes how the payments are to be applied, net of the Trustee's fee.11

Chapter 13 has certain advantages over Chapter 7. Chapter 13 is frequently used by debtors to catch up on mortgage arrears, for example. Secured claims, such as car loans, can be restructured under Chapter 13, and delinquent taxes can be repaid over time, without interest. General unsecured claims need not necessarily be paid in full; instead, the requirement is that unsecured creditors receive at least as much out of the Chapter 13 case as they might have received from a Chapter 7 liquidation. Since, as noted earlier, most Chapter 7 cases are "no-asset" cases, this requirement is often easily met. Additionally, the discharge in a Chapter 13 case is much broader than the Chapter 7 discharge, manifesting congressional intent to encourage more debtors to file under Chapter 13 to make an effort to repay at least a portion of their outstanding indebtedness.

The choice of Chapter 7 or 13 bankruptcy is one best left to an insolvency professional. Although the relative ease of obtaining a Chapter 7 discharge makes that the more tantalizing option, Chapter 7 cases are carefully scrutinized by the United States Trustee's Office and, where there is a "substantial abuse" of the provisions of Chapter 7, this branch of the Justice Department will not hesitate to file a motion to dismiss a Chapter 7 case under section 707(b) of the Bankruptcy Code. Moreover, if the debtor is behind in house payments, has tax problems, or might be in danger of losing a nonexempt asset if she files under Chapter 7, Chapter 13 may be the better option.

Credit Counseling

Resolving debt problems through a credit counseling or debt consolidation agency has a great deal of surface appeal. Rather than ignoring or hiding from his or her creditors, the individual responds proactively to the financial crisis. Instead of the "stigma" of bankruptcy, the person is applauded for making a sincere effort to repay his or her debts. As compared to those pursuing either of the previous two approaches, the person in the debt repayment program can arguably claim the moral high ground.

The problems with consumer credit counseling stem in large part from the fact that the market has become flooded with shady operators looking to make a fast buck. Stressed-out people too often will grasp at the first lifeline thrown their way - even if the lifeline is attached to nothing at the other end. While there are reputable agencies in the marketplace, extreme caution is warranted before recommending this approach.

In November 2003, Minnesota and the Federal Trade Commission joined the states of Texas, Missouri and Illinois in taking legal action against AmeriDebt, one of the nation's largest consumer credit counseling agencies. The Hennepin County District Court complaint filed against AmeriDebt alleges violations of Minnesota statutes regulating debt prorating agencies, as well as false advertising, deceptive trade practices, consumer fraud, and conducting business in Minnesota without a certificate of authority from the secretary of state. Specifically, the complaint accuses AmeriDebt of

… fail[ing] to disclose in its television and radio advertisements the material fact that it charged consumers an up-front fee equaling 3 percent of the consumer's outstanding debt owed to creditors (an average amount of $327), plus monthly fees of $7 per creditor, with a $20 minimum monthly fee (an average monthly fee of $33) throughout the three- to five-year term of the consumer's debt management plan. AmeriDebt's print advertisements represented "No Upfront Fees," while, in fact, AmeriDebt charged consumers upfront fees equaling 3 percent of the consumer's outstanding debts to creditors (an average amount of $327). AmeriDebt also represented that it referred consumers to an "outside" lender, yet failed to disclose financial ties between the lender and AmeriDebt.12

The AmeriDebt Complaint seeks declaratory and injunctive relief, restitution, civil penalties, costs and reasonable attorney fees. In response to the state's lawsuit, AmeriDebt stated that it would defend itself "vigorously." In the meantime, according to its Web site, AmeriDebt is "not accepting applications from Kansas, Michigan, Missouri, Illinois, New York, Pennsylvania, Texas, and Minnesota,"13

While AmeriDebt has been singled out by several states and the FTC for alleged consumer fraud violations, the Internal Revenue Service has also stepped into the controversy over credit counseling organizations. In testimony before the House Ways and Means Committee Subcommittee on Oversight Concerning Section 501(c)(3) Credit Counseling Organizations, IRS Commissioner Mark Everson pledged that the Service would "aggressively scrutiniz[e] applicants and existing organizations to ensure that organizations seeking or having tax exempt status as credit counseling organizations warrant that status."14

As Commissioner Everson noted, "to be exempt under section 501(c)(3), existing [IRS] rulings and cases indicate that an organization that provides credit counseling must limit its services to low-income customers or must provide education to the public on how to manage personal finances as its primary activity."15 Aside from the obvious advantage of being tax-exempt, "[o]rganizations recognized by the [Internal Revenue] Service as described in section 501(c)(3) often are excluded from coverage under FTC rules, as well as state and local consumer-protection laws. This exclusion appears to be one of the primary drivers for the increase in the number of these [credit counseling] organizations."16 However, instead of the "individual budget assistance and public education programs that formed the original basis for exemption under section 501(c)(3) … these services have been replaced by promises to restore favorable credit ratings or to provide commercial debt consolidation services."17

In its warning that some credit counseling agencies "are engaging in questionable activities",18 and urging consumers to "be wary of the 'quick fixes' offered by some organizations",19 the irs has published the following tips for consumers to consider in evaluating consumer credit counseling agencies:

• Check that the organization will help you manage your finances better through counseling and education.
• Carefully read through any written agreement that a credit counseling organization offers. It should describe in detail the services to be performed; the payment terms for these services, including their total cost; how long it will take to achieve results; any guarantees offered; and the organization's business name and address.
• Beware of high fees or required "voluntary contributions" that, with high monthly service charges, may add to your debt and defeat your efforts to pay your bills. It is illegal to represent that negative information, such as bankruptcy, can be removed from your credit report. Promises to "help you get out of debt easily" are a red flag.
• Make sure that your creditors are willing to work with the agency you choose. If they are, follow up with those creditors regularly to make sure your debt is being paid off.
• Check with state agencies and your local Better Business Bureau to find out about a specific credit counseling organization's record.20

Conclusion

Before offering even preliminary advice to a fiscally challenged client, it is important to be aware of the range of responses available to meet the crisis. Choosing the best option may require an association with an insolvency specialist, but with a basic understanding of debtor-creditor law the practitioner should be in a position to offer a general assessment of the client's position, and to make a referral where appropriate.

NOTES
1 Statistics are taken from the American Bankruptcy Institute's Web site, http://www.abiworld.org/stats/newstatsfront.html, except as otherwise noted.
2 Consumer Federation of America and National Consumer Law Center, "Credit Counseling in Crisis: The Impact on Consumers of Funding Cuts, Higher Fees and Aggressive New Market Entrants," April 2003, p. 7.
3 Minn. Stat. §550.37, subd. 18 (2002) (note the exception for farm equipment held in a family farm partnership, Minn. Stat. §550.37, subd. 5).
4 Child support wage withholding orders are not subject to these limitations.
5 See generally, Minn. Stat. §571.921.
6 Minn. Stat. §571.921(b).
7 Title 11, United States Code.
8 The so-called "federal exemptions" are found in 11 U.S.C. §522(d). An example of a "federal non-bankruptcy law" exemption is 42 U.S.C. §407, which provides an exemption from levy and execution for Social Security payments.
9 See Bankruptcy Rule 4007(c). See also 11 U.S.C. §523(c), which refers to four specific classes of non-dischargeable debt.
10 Local Bankruptcy Rule 3015-1(a). The local form Chapter 13 plan can be downloaded from www.mnb.uscourts.gov.
11 By statute (28 U.S.C. §586(e)(1)(B)(i)), the fee may not exceed 10 percent.
12 Minnesota v. AmeriDebt, Inc., Complaint, 2 and 3, Hennepin County District Court.
13 http://www.ameridebt.org/index.cfm.
14 Written Testimony of Mark Everson, Commissioner of Internal Revenue, Before The House Ways and Means Committee Subcommittee on Oversight Concerning Section 501(c)(3) Credit Counseling Organizations, November 20, 2003, p. 5.
15 Id., p. 3.
16 Id., p. 4.
17 Id.
18 irs News Release 2003-120, "irs, ftc and State Regulators Urge Care When Seeking Help From Credit Counseling Organizations," October 14, 2003.
19 Id.
20 Id.

The views expressed herein are those of the author, who acknowledges with thanks the contributions of Hon. Nancy C. Dreher, United States Bankruptcy Judge, and Marie Martin, associate at Hoglund, Chwialkowski, Greeman & Bergmanis, PLLP.

THOMAS E. JOHNSON is counsel to Jasmine Z. Keller, Standing Chapter 13 Trustee for the District of Minnesota. He a member of the American Bankruptcy Institute.